How to identify a Ponzi scheme?
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How to identify a Ponzi scheme?
Are cryptocurrencies creators of practical projects, or a complex Ponzi scheme where new investors feed the earlier ones?
Navigating Web3 tides with focused insights
Author: Nat Eliason
Translated by: TechFlow
Are cryptocurrencies creators of useful projects, or are they complex Ponzi schemes that feast on new entrants?
Different people will give different answers. Some believe cryptocurrencies might be the second coming of Jesus for finance, while Charlie Munger calls it “a venereal disease… with no value whatsoever.”
There's a problem when evaluating the crypto industry: whether evaluators truly understand certain terms, or if they're misusing terminology without clear context. Yes, there are Ponzi schemes in crypto—but most projects aren't. And even if something isn’t a Ponzi scheme, that doesn't mean it's a good project. We need more expressive ways to describe whether a project is alive, dead, or fraudulent.
This article attempts to build a framework for judging crypto projects.
I divide projects into two meta-categories: Living and Dying. Within these, I define four subcategories: Pyramid Schemes, Ponzis, Tulips, and Consumer Products.
By organizing these categories, we get a useful framework to examine both new and existing projects and assess their long-term viability.
Living Projects
A living project has net consumers in its economy—people who spend money using the service without being paid to do so. They pay for value received.
One example is AAVE on Ethereum. When you deposit funds and borrow from AAVE, you pay fees for the service. AAVE does not reward you with tokens just for borrowing, so once you take out a loan, you become a net consumer within the AAVE economy.
If AAVE can manage its costs well, it becomes a profitable, sustainable business—a project that can survive long term.
Uniswap is another strong example. It earns transaction fees on every trade and does not pay users UNI tokens simply for using the platform. People just use it. Yearn is a third example. Users happily pay Yearn a 20% performance fee for automated compounding or risk management services, without receiving additional token rewards for usage. This is real demand.
Outside the crypto world, many "living" businesses exist in real life. The taco truck where I occasionally buy lunch is a "living" business. I pay cash for tacos and don't receive mysterious TACO coins redeemable in some TACOVERSE. The taco truck has net consumers, revenue, and possibly even profit margins.
Unfortunately, many projects in crypto are not "alive," even if they appear to be—they're slowly dying.
Dying Projects
If a project spends more on incentives and token emissions than it earns in user-generated revenue, it is a dying project.
Many such projects claim token emissions aren't real expenses, but we must treat them as such. No one seriously believes their project’s TVL would remain unchanged if token emissions were fully turned off. Crypto participants constantly hunt for free money machines. If your product isn’t genuinely used, once you shut down the printing press, capital will flee elsewhere.
Terra’s Anchor Protocol is a recent, heartbreaking example. It had real consumers willing to pay to borrow on the platform. But to attract capital, Anchor had to inflate yields artificially—spending far more than it earned.
This kind of unsustainable growth isn’t unique to crypto. Uber is a famous real-world case. Today, Uber is expensive because earlier subsidies from venture capital have dried up. In other words, Uber replaced taxis in some cities only by burning cash through subsidies to fuel unsustainable growth. Now that the money is gone, taxis are making a comeback.
Before venture capital became widespread, most companies started as genuinely sustainable businesses, gradually growing into global giants. Now, companies can burn billions to skip the boring slow phase and hope to eventually become sustainable—if they succeed.
“Dying” may sound harsh, but it reflects direction. If a project cannot flip the script—getting users to pay more than the subsidies it gives—it will die. Many startups begin in this dying state, but that doesn’t guarantee death. Still, we should avoid overly dramatic language when describing them.
These are the two most important categories: if a project hasn’t figured out how to transition from dying to profitable, it isn’t yet a “real” business—at least in my view. Few crypto projects achieve this. To refine further, we can classify Living or Dying projects into four types: Pyramid Schemes, Ponzis, Tulips, and Consumers.
Pyramid Schemes
A pyramid scheme generates income primarily by charging people to enter a system. As a participant, your main way to earn is recruiting others to join—and taking a cut of their payments. This creates a pyramid-like structure.
Early joiners who recruit many people make the most money. The later you join, the fewer recruits are available, and the less you can earn. Eventually, newcomers can’t recoup their initial investment.
In crypto, it's actually hard to find good examples of this category. Many projects let early investors profit more than late ones, but that alone doesn’t make them pyramid schemes. The key question is: Do you earn money by convincing others to buy something—and do you get paid directly by those you convince?
Cardano might qualify. They focus on getting YouTube influencers to promote Cardano, then have followers stake into their nodes, allowing influencers to earn a share of all staking rewards generated. This is clearly a pyramid-like structure.
Evan Armstrong argues NFTs like Bored Apes resemble “multi-level marketing” (MLM—a milder form of pyramid scheme), but they lack the critical element of generating cash flow from recruited members. Bored Ape holders don’t earn a cut from buyers they influenced. The only similarity to a pyramid is that early investors profit more than late ones—but that’s true for nearly all investments. We don’t call Facebook a Ponzi scheme just because its stock dropped 80% and late investors lost money.
Ponzi Schemes
Ponzi schemes are the hardest to prove. They are scams with no real underlying business generating income—later investors’ money is simply recycled to pay earlier investors. They also typically involve intentional fraud, which distinguishes them from merely unsustainable businesses.
Bernie Madoff’s operation is perhaps the most famous example. He faked trades to explain profits, but in reality, he was recycling money from new investors to pay old ones—fraud (what’s often called “robbing Peter to pay Paul” in Chinese). He ran an investment business, but part of the returns were fabricated.
Bitconnect may be the clearest Ponzi scheme visible in crypto. They promised 1% daily compound interest, but those returns came entirely from funds poured in by other users.
Based on what we know now, Anchor Protocol’s 20% yield on UST wasn’t a Ponzi scheme. They didn’t falsely claim the yield came from some special source. They said it was marketing spending by the Luna Foundation to drive UST adoption—no different in practice from how VCs subsidized Uber. I’m not saying it was right or wise—the collapse of Luna was terrible—but I don’t see how Anchor’s actions were criminal.
Tulip Schemes
Ponzi schemes pay investors with money from other investors. Tulip schemes are different: they describe assets that grow in value purely because other investors believe they’re valuable. Classic tulip schemes are investments with almost no utility beyond speculation or store of value.
Many things in the world are tulip schemes—we just differ in how long we expect them to last. Gold is a tulip. Art is a tulip. Any status symbol might be a tulip. Most NFTs are tulips—even if they grant access to a community.
Calling something a tulip scheme doesn’t mean it has no value. We can make gold into jewelry, but the only reason we do so is precisely because gold itself is valuable. And we think gold is valuable only because it’s rare and others believe it’s valuable. If we all stopped believing in gold—or if alchemy were perfected—no one would care about gold anymore.
In this context, a tulip’s value rests mainly on subjective beliefs about its importance. As long as others think it’s valuable, it is.
Consumer Products
Finally, “consumer products.” This category is a bit odd because it lacks the explicit “pay-to-play” mechanics of pyramid schemes, but it serves as a useful umbrella to distinguish real crypto projects from others.
Ponzi and pyramid schemes create the illusion of consumption without real spending. While tulips may have value, actual consumption is minimal in their economy, making it hard to classify them as true investments or even pure speculation.
Without real spending, a crypto project is either dying or purely speculative. Thus, spending behavior is a crucial factor in assessing any project’s legitimacy. You should ask:
1. Who is spending money?
2. How much are they spending?
3. Does the amount spent exceed the project’s emissions?
At least in crypto, a project usually needs real outflows in non-native tokens or assets. This is a challenge many games face—I’ve written about it in One vs. Two Tokens. If a game earns all its revenue in its own token, it must dump that token on the market to realize actual income. Earning in external assets (like ETH or USDC) is more legitimate.
We’ve now completed our classification. Let’s apply it to various projects and test our intuition about their legitimacy.
Dying Projects Where Early Investors Profit
What happens when an unsustainable business lets some people profit before crashing dramatically?
WeWork is a great example. Benchmark initially invested $17 million and later sold part of its stake for $315 million. If WeWork is an unsustainable business and early investors profited at the expense of later ones, is it a Ponzi scheme?
It feels close, but it’s not really a Ponzi scheme because it genuinely tried to become sustainable (and still hasn’t given up). So early investors profiting from an unsustainable business doesn’t automatically make it a Ponzi. For that, you need fabricated operations or a complete lack of effort to run a real business.
Many tech startups look like this. They raise money chasing big visions, but early investors exit by selling shares to later investors. In reality, early investors don’t need the business to succeed or become sustainable. Are all tech startups Ponzi schemes? Or tulip schemes? They may be tulips, but they’re definitely not Ponzis. They’re just in a dying state.
What about current crypto projects? Many launch, get bought by early investors, go through a hype cycle, drop 80–90% or more, and never recover. Those who sold at the top made huge profits—paid for by later buyers. Are these Ponzi schemes? Again, I’d say it depends on whether they ever ran a real business. Solana crashed 85% from its peak. Someone who bought at $3 and sold at the top made a fortune. But that doesn’t make it a Ponzi or pump-and-dump. Solana built real products; users pay SOL to use them.
Bitcoin and Ethereum
Where do Bitcoin and Ethereum fit? Critics sometimes call them Ponzis, but that doesn’t hold up. Neither involves operating a fake business to deceive investors. You also don’t get cash flows from holding them (at least not yet).
Bitcoin sits between a tulip and a dying project. Beyond trading or holding, you can’t do much with Bitcoin, though transaction fees do generate some economic outflow. However, block rewards far exceed transaction fees, so miners still receive heavy subsidies from newly minted Bitcoin. If fees were high enough to justify mining without block rewards, it would be a living project—but it hasn’t reached that point.
Ethereum is currently a dying project. You can spend to use Ethereum for many things, but emissions still exceed spending. After the Merge, Ethereum’s spending may exceed emissions—making it a living, sustainable business. It would become the first proof-of-stake chain to achieve this, as all competing L1s today are large-scale, unsustainable operations.
But neither qualifies as a true Ponzi scheme. At worst, they’re tulips or dying projects.
Play-to-Earn
What about play-to-earn games like Axie Infinity and STEPN, with inflationary minting loops?
In my article on STEPN, I criticized its minting schedule for causing runaway inflation, eventually devaluing sneakers and tokens. I also believed its GMT token was severely overpriced, lacking any associated cash flows or revenue to justify its valuation.
So these games are clearly dying projects—but are they Ponzis? It’s tricky, because outside the game there’s no real business, yet in-game work has some value, similar to gray-market economies in Web2 games. So “value exists only in the game” doesn’t mean it’s unreal. Digital sneakers are very different from a set of silverware, but digital sneakers are still things people value while playing.
But these games don’t die exactly as I described earlier, because they don’t pay massive free bonuses to incentivize activity. People rush in because they want to play more. So it leans toward the tulip model—prices driven largely by speculation around “what digital sneakers can do,” rather than any real underlying value. Perhaps “dying tulip” is the most accurate label.
Why isn’t it a pyramid scheme? Because you don’t benefit directly from recruiting others into the game—except indirectly through ecosystem growth. If you gave someone your referral code and earned 10% of their GST, that would clearly be a pyramid scheme, but no such mechanism exists. I believe some future games will adopt this as a “growth hack.”
What’s the Point?
We can practice this analytical skill with countless project examples. It may seem pedantic, but I find it helpful for analyzing new and existing projects and predicting their futures.
The first question must be: Is there real spending happening? Can the project generate cash flow from usage?
If not, where does the money come from? Is it just a speculative tulip? Or a Ponzi or pyramid scheme?
If there is real spending, is the project living or dying? Does it rely on massive token emissions to drive that spending? Or does spending happen organically, without added incentives?
This is how I assess which projects can survive bear markets. YFI/ETH brutally corrected, but the business seems solid. MakerDAO is another great example—its token price is terrible, but the business itself is healthy.
Another big question: Which competing L1s can transition from dying to living? If Ethereum’s Merge goes as planned and maintains consistent fee levels, it should become deflationary and evolve into a business with stable cash flow. Can other L1s achieve the same? For Solana, the seemingly impossible task is generating enough on-chain activity to become sustainable at current fee levels—but I think critics underestimate the impact of integrating products like Solana Pay into platforms like Shopify.
Everything looks great in bull markets, but we’re a bit more sober now. This framework helps analyze projects and separate the real from the fake.
Original link: https://crypto.nateliason.com/p/ponzi?s=r
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